How to Interpret Quarterly Cash Flow Reports (Also Known as Appendix 4C or 5B)

How to Interpret Quarterly Cash Flow Reports (Also Known as Appendix 4C or 5B)

Premium SelfWealth members would be well aware that a large proportion of the SelfWealth community use their trading accounts to actively buy and sell small-cap stocks. Investing in shares at this end of the market comes with greater risk, however, some of today’s biggest companies once started life on the ASX as small-cap shares.

As much as investors may want to spot the next ‘big’ stock while it is still trading in its infancy, it is more important to be able to identify shares that look unlikely to achieve this feat. Financial statements are a telling indicator when it comes to making such judgements, however, waiting for half-yearly or annual reports delays vital information. This is why investors should pay close attention to quarterly cash flow reports.

Also called an ‘Appendix 4C’ or ‘Appendix 5B’, quarterly cash flow reports detail a company’s financial position through its cash flow. This allows investors to gauge whether the business is meeting its objectives. These updates, often accompanied by an activity report, are provided in January, April, July and September, covering business operations from the prior quarter.

Quarterly cash flow reports are common in the small-cap sector. Companies specified by the ASX, including mining or oil and gas exploration entities, plus smaller businesses typically yet to turn a profit or achieve positive operating cash flow, must submit such updates to the market. Recent changes to the reporting structure have also commenced. The ability to interpret a quarterly cash flow report is a vital tool for any small-cap investor. Here’s what you should look out for.

 

Cash flow from operating activities

This section details the capital that a business earns and spends in the normal course of its business operations. Positive operating cash flow generally marks a transformational point for many companies, however, this usually takes extensive time. 

Receipts or cash flow coming into the business is often different from revenue. While you may still get a rough indication as to how a business is performing, the difference is because of timing differences that arise between when revenue is recorded, and when cash is received. 

Receipts will often vary from one sector to the next. For junior mining explorers, it is typical to see no receipts. For some tech or biotechnology shares, you may spot government grants, which reflect funds coming into the business. 

One of the most important things is to track how a company spends its funds. That is, whether the costs are appropriate, consistent between quarters, or outpacing growth in receipts. Cash ‘burn’ ultimately shapes a company’s future growth and funding prospects. You should also audit whether expenditure is in line with the company’s forecast in the prior quarterly cash flow report.

 

Cash flow from investing activities

Where a business acquires or disposes of assets that are integral to its operation, all associated cash flow will be displayed in this section of a quarterly cash flow report. The outgoing template used by the ASX for quarterly cash flow reports requires companies to provide the details relating to any transactions in the section titled ‘acquisitions and disposals of business entities’, which is shown below.

Acquisitions and disposals may include mining tenements or projects. If a company has sufficient capital to fund its acquisitions, it is not uncommon, nor necessarily a red flag if there is a cash outflow from investing activities.

 

Cash flow from financing activities

When it comes to funding operations, the market will typically favour the use of existing cash reserves in place of debt or new equity. With that said, there are instances where these forms of funding have a distinct benefit, particularly if there are immediate opportunities available to fund growth. 

In any case, investors should pay attention to the details of this section to establish whether a company is dependent on debt or issuing financial instruments in order to stay afloat. This could be the sign of an unsustainable business, or at least one that is taking longer to grow than management may have expected, especially if cash flow from operating activities is not showing growth.

 

Net change and reconciliation of cash and cash equivalents

These two sections will provide a snapshot as to the overall change in cash and cash equivalents across the duration of that period. This will include cash gained from or used in the three areas mentioned above – operating activities, investing activities and financing activities. The reconciliation statement breaks this down accordingly.

It is not uncommon to see companies holding call deposits or bank overdrafts as opposed to bank balances, but the key thing here is you want to see sufficient funds to at least sustain current operations for subsequent quarters, if not ramp up operations in pursuit of growth.

 

Payments to directors, related entities/parties and their associates

Under these sections, which have been consolidated in the latest reporting template, you will find details on payments that have been extended to directors or related entities. These payments should be commensurate with your expectations as to the size and performance of the business, however, the amounts should also not come as a surprise if you have previously referred to the company’s prospectus or annual report for information on such key payments. 

 

Financing facilities

An often overlooked section of quarterly cash flow reports, this section will help you understand what debt funding the company currently has and the associated terms. An important consideration is the interest rate applicable to any financing, as these costs will be incurred as an outgoing payment in the course of the business’ operating activities. 

The left-hand column, total facility amount, illustrates the size of any debt the company has taken out. The right-hand column, amount drawn at quarter end, indicates how much of that funding has been used. The latest reporting template, shown below, now spells out how much debt remains available. If a company is using the old reporting template, you would calculate this from the difference between the figures in the two columns.

 

Estimated cash outflows for next quarter / cash available for future operations

This is one of the most important sections of an Appendix 4C or 5B, yet many investors don’t even read this far into the report. It is also one of the biggest changes amid the latest reporting template. Previously, this section would provide an estimate for the next quarter’s operating cash outflows. 

If a stock is still using this reporting format, it is important to consider if the figures seem aligned with events or developments the company is currently working towards. A spike in forecast cash outflows could signal the business is looking to drive growth or pursue certain opportunities, however, this will depend on the nature of spending. For example, manufacturing costs are more likely to have a near-term return on capital than research and development or exploration activity. Meanwhile, increasing administration and corporate costs may warrant closer examination. 

Under the new template, a company will be required to provide a forecast ‘runway’ for its operations based on the total cash and funding it has on hand, plus the operating cash flow from the most recent quarter. Remain wary that last quarter’s operating cash flow could vary significantly in the coming quarter, so multiple quarters’ coverage is ideal to avoid dilutive funding. If there is a shortfall, you may also want to independently review your own calculations in light of the company’s explanation(s). 

 

Why quarterly cash flow reports hold such importance

Investing in shares requires extensive due diligence and insight into a company’s operations. ‘Voluntary’ announcements provided by a business give investors the means to stay informed as to the company’s progress towards its goals. However, few documents provide a more transparent and honest account of the company’s likelihood to achieve those objectives than the quarterly cash flow report. 

An Appendix 4C or 5B report will detail how a company manages its cash flow, while also allowing you to form a judgement as to the growth prospects of that stock. This makes it one of the most important announcements that you should monitor if you intend to buy or sell small-cap stocks that tend to be more risky and volatile than established businesses generating consistent profits or self-funding activities through positive operating cash flow.

 

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SelfWealth Ltd ACN 52 154 324 428 (“SelfWealth”) (Australian Financial Services Licence Number 421789). The information contained on this web site is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a financial adviser. Taxation, legal and other matters referred to on this website are of a general nature only and should not be relied upon in place of appropriate professional advice.

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